Conditions on money markets continue to thaw

Conditions on money markets continue to thaw, with USD short term funding costs falling further in Asia on the back of the latest initiatives from central banks and governments aimed at increasing liquidity.

The Federal Reserve have confirmed they will raise the interest rate it pays banks for the excess cash they keep on deposit, in order for them to keep pumping funds into the financial system without affecting the central bank’s monetary policy. Fed. officials acted after the initial rate they set on 6th October failed to keep the benchmark U.S. overnight interest rate close to the target set by policy makers.

The previous rate was 0.75% below the target. The Chairman of the Federal Reserve, Ben Bernanke wants to ensure that his efforts to flood the financial system with cash doesn’t interfere with the policy rate. They started paying interest on reserves this month after gaining authorization under the financial-rescue bill passed by Congress.

The improvement in credit markets, however, has done little to ease concerns about the outlook for the global economy or encourage any move out of defensive currencies. The Euro has fallen to its lowest level for over a 18-months versus the USD as support at $1.30 and then $1.28 gave way. Further losses are seen, with the single currency also pressured against the yen as it continues to be benefit from its safe haven status.

Sterling deteriorated further against the Euro and reached a 5-year low against the Dollar, after Bank of England minutes released yesterday morning confirmed that policy makers voted unanimously to reduce UK interest rates by half a percentage point this month.

The Bank of England, European Central Bank, the U.S. Federal Reserve, Bank of Canada and Sweden’s Risbank all unexpectedly reduced interest rates in an emergency meeting on 8th October – this was an unprecedented coordinated effort to ease the economic effects of the worst financial crisis since the Great Depression.

The committee noted that the recent global reduction in interest rates could not be expected to resolve the current problems within financial markets and that a significant increase in the capital sector would be required.

The nine-member Monetary Policy Committee (MPC) – led by Governor Mervyn King, confirmed that the U.K. economy is expected to sink into recession in 2009. He also confirmed that House prices in the U.K. are likely to continue to fall.

Policy makers cited lower oil prices, the weakening economy and rising unemployment as reasons why the current 5.2 percent inflation, more than double the 2 percent target, was unlikely to become embedded in the economy through faster wage growth.

There is now increased speculation that the Bank of England are likely to follow this month’s emergency interest-rate reduction with another potential half-point cut at the next scheduled meeting on 6th November.

Hungary opted to raise its benchmark interest rate by 3 percentage points yesterday afternoon. (the biggest increase in five years) and pledged measures to shore up the economy after steps to halt the flight of investors failed.
Stocks, bonds and the Forint have plunged in the past two weeks on concern that the country will face difficulties in financing its current account and budget deficits with in the face of the global credit freeze. This has put the Forint under increased pressure, prompting the Magyar Nemzeti Bank to lift the two-week deposit rate to 11.5% in an emergency move.

New Zealand opted to reduce interest rates by a record 1 percentage point to 6.5% during the early hours of this morning. This is the largest reduction in interest rates since the Reserve Bank began using the official cash rate in 1999. There is speculation that the Reserve Bank may need to reduce interest rates again within the short-term, however, it is unlikely that any future reduction will be as aggressive.

Sweden’s Riksbank also opted to reduce interest rates by half a percentage point to 3.75% this morning (the second cut in two weeks.) Sweden pledged 1.5 trillion kronor ($192 billion) to guarantee loans this week to help reduce bank borrowing costs and revive lending in the financial system. The Riksbank are expected to reduce interest rates by up to half a percentage point again in the near future.